Foreign exchange options pros are at odds over South Africa's rand and related options bets, as the currency continues to weaken against the U.S. dollar and amid the launch of an official South African government investigation into the rand's fall. In a controversial move, the Reserve Bank of South Africa hiked rates by a full percentage point last week to counter the inflationary risks posed by last year's weakness in the rand, which fell 37% against the dollar. Following these moves, Bear Stearns thinks the rand will find support and gain from its recent lows and as a result the firm is recommending zero or low-cost option packages to take advantage. Other firms, such as Citibank/Salomon Smith Barney and BNP Paribas, have less confidence in a rand rebound and said the rate hikes will only further crimp economic growth.
Speculative investors who want to take a punt on the rand should consider selling one-month dollar puts/rand calls struck at ZAR11 at 30% implied volatility and buying six-month dollar puts/rand calls at ZAR10.75 at 20% vol, said James Fauset, hedge fund salesman at Bear Stearns in London. He said the trade can be structured as low-cost in even amounts or as zero-cost if an investor buys the trade in a ratio of USD16 million (notional) of the first option and USD10 million (notional) of the longer-dated option. "We think there will be some strong news that could push the rand down to test ZAR10 again, we feel it will stay in this range for a couple weeks and then come lower," he explained. Spot was ZAR11.85 Wednesday.
But other bankers are not so sure. Leon Armstrong, an fx options strategist for emerging markets at Citibank in London, said volatility is so high for a reason and that is the concern that the central bank or outside authorities, such as the International Monetary Fund, could intervene to prop up the rand. As a result, he does not believe in selling short-dated vol to achieve a low-cost structure. "You have to be able to make a 100% clear statement that there will be no intervention, and you can't, so in that environment I wouldn't want to be selling a short-dated option," he said.
Paribas expects the rate hike to hurt the rand and is advocating a similar structure to Bear Stearns but with the opposite view on spot movement. "Three-month risk reversals are at 7% [in favor of dollar calls]--most people think the rand is in for a rough time ahead," said an emerging fx official.